1 Opening Its Doors: India’s Emergence on the Global Stage JERALD SCHIFF here can be little doubt that India is an emerging global economic Tpower. India’s economic growth has averaged some 8 percent over the past three years, placing it among the world’s fastest growing economies. As a result of more than a decade of solid growth, India’s share of world output, at purchasing-power-parity-adjusted exchange rates, has increased from 4.3 percent in 1990 to 5.9 percent in 2005. Growth has been robust in the face of shocks, including the Asian crisis of 1997–98, several below- par monsoons, and the recent sharp increases in energy prices. In line with good growth, poverty has declined dramatically, with estimates indicating a drop in the poverty rate from 41 percent in 1992–93 to less than 29 per- cent in 2000. The reform process that has helped make this possible—and which began in earnest in 1991—has made steady progress despite several changes in political leadership. Looking ahead, it appears that the broad path of reform—although not the pace or details—is firmly established. And success begets success. India is now more than ever a focus for inter- national investors, who are eager to take part in a new India. India’s recent rapid development has gone hand in hand with a marked opening of its economy. Tariffs have come down dramatically in the last decade, while capital account restrictions are being gradually lifted. During 2003/04–2004/05 India’s imports (including services) rose by 39 percent a year, twice as fast as in 1990–2002, buoyed by strong investment and consumer demand. Exports grew by 37 percent a year, up from 18 percent growth in 1990–2002, as India benefited from the commodity boom and 1 ©International Monetary Fund. Not for Redistribution 2 • OPENING ITS DOORS: INDIA’S EMERGENCE ON THE GLOBAL STAGE expanded into engineering goods, pharmaceuticals, and business services. There is also some evidence that India is increasingly tied into regional pro- duction processes, with Asia’s share in Indian imports rising steadily and with Asia becoming a major destination for India’s exports. Intra-industry trade with China, in particular, is rising rapidly helping plug India into global production networks. India is also integrating into global financial systems and has benefited from rapidly rising capital inflows, including into the Indian stock market. Reflecting these developments, India is playing a more important role in the global economy. A few examples only hint at the changes: • India contributed nearly one-fifth of Asian domestic demand growth over 2000–05. Looking forward, India is slated to be the second- largest demand driver in the region, after China. • India accounts for almost one-quarter of the global portfolio flows to emerging market economies, nearly $12 billion in 2005. • India is the world’s leading recipient of remittances, accounting for about 20 percent of global flows. • India is the world’s leading outsourcing destination and is fast emerg- ing as a top 10 tourism destination. • Indian corporates are emerging as key players in their own right. Reli- ance owns one of the largest refineries in the world, while Tata Steel is among the most efficient producers in the world. Indian firms, in industries including steel and oil, are looking abroad to acquire assets. And Indian corporates are increasingly carrying out their own research and development. In 2004 alone, Indian pharmaceutical companies filed about 200 patents. India’s demographics underline the potential for an extended period of rapid economic growth. India is an extremely young country, and is one of the few large countries forecast to sustain a growing labor force over the next 40 years (Figure 1.1). Estimates point to between 75 million and 110 million entrants to the labor force over the next decade, with the obvious potential to raise the economic output of the country and underpin India’s competitiveness. Also, because working-age people tend to have a higher propensity to save, India should benefit from a favorable saving trend that will help finance investment and fuel rapid growth. Opportunities, but Challenges as Well While India is poised for economic takeoff, continuing success is by no means assured. India’s development path thus far has been considerably ©International Monetary Fund. Not for Redistribution Jerald Schiff • 3 Figure 1.1. Working AgePopulation (In percent of total) 75 70 65 Thailand China 60 Philippines Brazil Indonesia India 55 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 Source: United Nations, Population database. different from those of Japan, China, Korea, and the other “Asian tigers” in previous decades. And some of these differences present unique challenges to the country as it moves forward. Growth in India has been led by services rather than manufacturing. While India’s role as an information technology (IT) provider has been well documented, and is a major growth engine for the country, more rapid development of the manufacturing sector will be needed to generate the sort of lower-skilled jobs that can serve as a ladder out of poverty for many. The current employment elasticity of growth in India implies that a 5 percent rise in real GDP leads to only a 2½ percent rise in employment, and unless this is raised substantially, the large number of new workers can become a massive problem for India rather than a boon. India has the potential to be a manufacturing giant, but needs to remove the consider- able roadblocks that industry still faces—notably poor infrastructure, rigid labor laws, and relatively inhospitable business and regulatory environ- ments. Moreover, the reliance on services growth implies a need for a large pipeline of well-trained engineers and scientists, which may not be forth- coming without significant reform of higher education. Second, in contrast to most other Asian economies, almost two-thirds of the population still derives its income from agriculture. While this reflects in part the limited supply of manufacturing jobs, high levels of illiteracy and extreme poverty in rural areas also mean that individuals may lack information about employment opportunities or the means to move else- ©International Monetary Fund. Not for Redistribution 4 • OPENING ITS DOORS: INDIA’S EMERGENCE ON THE GLOBAL STAGE where. A large share of the population relies on subsistence agriculture, and farming remains heavily rain-dependent, with irrigation lacking in many areas. The high correlation between agricultural growth and rainfall in India (about 0.65), illustrates the dependence of growth on rainfall. For India to achieve and sustain the sort of high growth it is targeting—in the range of 8–10 percent a year—productivity in agriculture needs to be raised, but agricultural workers also need to be provided with the basic tools and opportunities to move to new jobs in manufacturing. Third, India’s fiscal deficit and debt remain large, constraining its ability to act in key areas. With general government deficits still in excess of 7 per- cent of GDP and government debt above 85 percent of GDP, the govern- ment’s ability to meet the many urgent needs of its population—notably in rural and urban infrastructure, education, and health care—will depend on its success in raising additional revenues without choking off economic growth and limiting inefficient and low-priority spending. The infrastruc- ture gap remains large with inadequate roads, ports, airports, and power increasingly constraining India’s potential growth (Figure 1.2). Finally, India remains—despite its ongoing reforms—a relatively closed economy. Even though India has received much attention for its role as an outsourcing destination, trade linkages remain comparatively weak. Trade is low when compared to that of other Asian countries that pursued more export-driven growth strategies. India still only accounted for about 1 percent of the global trade in goods and services in 2005. Although trade with other emerging countries in Asia has expanded rapidly, India’s partici- pation in global production chains, while growing, is in its infancy. While the share of intra-industry trade in East Asia trade rose to 75 percent in 1996–2000 from 42 percent in 1986–90 (Zebregs, 2004), it only rose to 18 percent from 12 percent between 1992 and 2001 in India (Cerra, Rivera, and Saxena, 2005). As emphasized throughout this volume, the authorities will need to continue to open the economy to take full advantage of global- ization and ensure that India reaches its full growth potential. The Indian authorities are well aware of the challenges they face and are moving to address them. For example, trade tariffs have been coming down for a decade—most recently in the context of the 2006/07 budget—and there are plans to bring these down further to levels of member coun- tries of the Association of South East Asian Nations (ASEAN)—around 8 percent on average—by 2009. India is also active in bilateral and regional trade liberalization, with the South Asia Free Trade Agreement to begin in 2007, and with ongoing discussions with Mercosur, ASEAN, and China, among others. In addition, capital controls on foreign direct investment (FDI) in India and external commercial borrowing by domestic firms are ©International Monetary Fund. Not for Redistribution Jerald Schiff • 5 Figure 1.2. Measures of Infrastructure Access Telephone Mainlines (Per 1,000 inhabitants) 600 500 400 300 200 100 0 Korea Malaysia China Thailand Indonesia India Least developed Roads, Goods Transported countries (Billion tons per km) 700 600 500 400 300 200 100 0.96 0 China Korea India Electricity Production (Kwh per capita) 8000 7000 6000 5000 4000 3000 2000 1000 0 Korea Malaysia Thailand China India Least Indonesia developed countries Air Transport, Freight (Billion tons per km) 10 8 6 4 2 0 Korea China Malaysia Thailand India Indonesia Source: World Bank, World Development Indicators database.